India central bank ups interest rate in order to curb inflation

MUMBAI--India's central bank announced a surprise 25 basis point hike in its key interest rate Tuesday, signaling that taming inflation is its key priority, rather than spurring growth, just months before a general election.

After a meeting in financial hub Mumbai, the Reserve Bank of India (RBI) lifted the benchmark repo rate, at which it lends to commercial banks, to 8.0 percent. The cash reserve ratio, the amount banks must keep in hand to withstand financial shocks, was left unchanged at 4.0 percent.

India's currency rose on the news, firming half a rupee to 62.91 rupees to the dollar from Monday's more than two-month low. The unit has come under renewed pressure as investors fret about the impact of a rollback in the U.S. Federal Reserve's easy money policy on India and other emerging markets.

The rate hike was unexpected as most economists forecast rates would remain on hold, especially after a fall in the widely watched Wholesale Price Index last month to 6.16 percent year-on-year in December from 7.52 percent in November.

But RBI governor Raghuram Rajan said there was still upward pressure on inflation from economic factors such as the rising services prices.

"It is critical to address these risks to the inflation outlook resolutely in order to stabilize and anchor inflation expectations, even while recognizing the economy is weak and substantial fiscal tightening is likely" (in the January-March quarter), he said.

Tuesday's announcement disappointed business leaders, who have been clamoring for a rate cut to kickstart badly needed investment to spur an economy which has been growing at a decade low.

But Rajan said the "gravest risk" to the economy came from the increasingly important consumer price index, which remained "elevated."

Madan Sabnavis, chief economist, Care Ratings, said: "Usually (the) RBI talks about growth and inflation. But this time it was just inflation and inflation.

"The signal is that corporates should not expect growth to be driven by interest rate adjustments."

Shares on the Bombay Stock Exchange were trading 0.32 percent lower after the announcement.

The RBI under Rajan raised rates in both September and October to fight inflation, but then surprised markets by holding them steady in December even after inflation accelerated to a 14-month peak.

According to a macroeconomic report on Tuesday the central bank expects headline consumer price index inflation to remain above nine percent for the rest of this financial year to the end of March.

"Today's decision suggests that (the) RBI is not going to be overly focused on the growth angle unless of course (growth) collapses," said Ashutosh Datar, economist with the India Infoline brokerage.

India is due to hold the general election by May in which the scandal-tainted Congress-led government of Prime Minister Manmohan Singh is expected to fare poorly.

Singh, a renowned economist, is desperate to see signs of an upturn in the economy, which some analysts forecast will grow below five percent in the year to March — a far cry from near-double digit levels just a few years ago.